Bill Clinton Visits the Daily Show
by Alex Merced
(This is in Reference To This interview on the Daily Show)
In former President Bill Clintons appearance on the popular satirical news show "The Daily Show" I had to say I was very surprised at Clintons candidness. Clinton, shockingly enough somewhat understood the problems that are preventing the economy from moving foward much better than any Keynes following demand sider I've heard so far. I'm not saying that all of the suddent Bill Clintons an ally or fellow traveler, on the contrary he's very far from what I would remotley call a friend of Free Markets. In that I'd like to respond to many of his points and clarify some of his mistakes.
Worker Mobility
This is actually something I discussed on my series on labor economics, you can read what I wrote about worker mobility here. While Cliton ackowledged that the problem isn't the lack of jobs but the lack of qualified and geographically available labor (the local people don't have the rights skills, and the ones that do are stuck in houses they can't sell). Although what he doesn't venture into is why we have this gap in mobility and skills, cause it then dims the picture on his major policy recommendation... government guaranteed loans.
It's cause of the implicit government guarantees on Freddie/Fannie loans, and the explicit guarantee on Ginnie debt that was the major catalyst for many of these people stuck in these homes which they now can't sell and are less valueable than the loans they took due to price bubbles caused by government guaranteed loans. Easy
It cause of the government guarantee of Sallie May debt that so many people can more easily and painlessly pay lavish tuitions at schools and walk away with degrees in which they learned very few if any practical skills in recession (My Bachelors is in Popular Culture Studies) and not skills that offer versatility in a changing job market (copywriting, data analysis, marketing, visual arts, programming/web design).
I'm not saying there is no value in a degree in something like ethnic studies and popular culture, but the risk in entering and succeeding in those fields is similar to that of joining the NBA. Essentially, like anything else easy money makes it easy for people to take more risk than they would usually take, if people had to pay higher rates on their loans or didn't get other types of financial aid they'd be more prudent in developing their skills (they'd still minor in their interest, but more than likely major in something like marketing or visual arts which is used in ALL industries). I can attest to this since I would of probably stuck with my original major, Computer Programming, if I was not on a scholarship. Actually I probably would've went to a local community college and transferred later on which would be the more prudent decision.
Bottom Line, since students were willing to take more risk in which skills to invest their education dollars you had a mal-investment or bubble in degrees which could not yield a return on the investment which results in a over supply of labor for some things and shortage of supply for other things. This is essentially mini occurances of the Austrian Business Cycle (easy credit leads to mal-investment which leads to market corrections).
So what would one expect if Bill Clinton had his way and Government Guaranteed loans were made for Small Businesses (it already happens under SBA, Clinton only wants to expand SBA). You'd have more small businesses starting which for sure would create jobs, but only some of those jobs would be sustainable since many of these new businesses might have risky business models that were made possible by this government guarantee (the bank wouldn't loan to a risky model naturally, so the entrepeneur would have adjust his model). The sustainable jobs that are created would've existed anyways since these companies have sound business models that would be able to be capitalized normally. Of the businesses that normally would have not gotten loans only a small chunk might survive which doesn't justify the mis-allocation of investment in the ones that don't survive which then taxpayers foot the bill for.
Construction Jobs
Clinton goes on to talk about green infrastructure and construction jobs because construction is where the most unemployment is (cause the bubble was in housing construction, so many people forgoes developing other skills to participate in the glut of construction demand at the time). Although using the same mechanism of guaranteed loans to create construction jobs is the reason so many people were concentrated in those jobs and are now unemployed in the first place. The 25% unemployment in construction workers isn't a signal that this is an industry that needs stimulus, it's a result of the mal-investment from the housing bubble and sustaining it will make that number bigger in the long run when the bubble re-occurs and even more of the workforce if over-concentrated in construction.
Bottom Line
Tax Cuts for Small Businesses and deductions for particular expenditures is the equivalent of easy credit as far as human behavior, so the solution from the republicans isn't appetizing as well. Although, instead of trying to understand why the situation is what it is, Cliton uses the current state as justification that there is need of more the current government subsidies to different industries.
In Order for the economy return to a sustainable functioning economy, participants need the incentives to make sustainable decisions and that incentive is called "Risk". Loans, Deposits, Insurance, or anything else should not be guaranteed by taxpayer money, and if those moral hazards are removed then people at all levels will be more prudent which means lowering taxes and giving them their money back would make a whole lot of sense since the population will have the right environment to make the right decisions.
Showing posts with label Fannie. Show all posts
Showing posts with label Fannie. Show all posts
Friday, September 17, 2010
Wednesday, June 30, 2010
Regulating Enterprise
Regulating Enterprise
by Alex Merced
Time and time again we hear in the news that we need stronger regulation on Oil, Housing, and Banking to prevent all the problems we've seen over the last few years. Today, I'd like to make the argument that the problems with all three of these sectors has everything to do with government intervention in the market and that the best regulation would be the natural regulation of natural risk in the markets. In the name of populism much of this natural risk has been removed from these enterprises in the name of "promoting business", "job creation", and "economic growth".
The initial problem with this rhetoric is that growth is always good, so rushing growth or artificial growth must be good too. For example, if I want to bulk up quicker I could begin to take steroids, although while that is growth it's not sustainable since I haven't built the discipline and lifestyle needed to maintain that bulk, so I become dependent on the steroids to maintain it.
So let's take a look at three types of natural risk that effect the entrepreneur when they are making the decision to enter an enterprise, and on how to run the enterprise. We'll see that these policies remove the aforementioned risks and like steroids prevent the kind of discipline needed to create sustainable businesses and growth.
Risk # 1 - The Ability to Raise Capital
Arguably, if an entrepreneur can't raise the money then he may never start the enterprise at all. Why would raising capital be difficult? This could be for a variety of reasons that all have to deal with he viability of the business and if potential investors/lenders see a demand for product/service, are the potential liabilities addressed, are the margins too thin, is it profitable in the short term? If government were to intervene to make capital easier to raise for such enterprises, it's easy to see how more of them would exist despite these typical investor concerns.
Oil - Oil is a very difficult business without government aid, because investors aren't typically very optimistic about the chances of finding oil when doing exploratory drilling. So to encourage investment into oil in the 60's and 70's tax shelters were created for oil investment in the form of Direct Participation Programs, and during a time of 70% tax rates one can see how a tax haven can be quite a benefit, you'd actually profit from the tax savings alone. So capital was being sucked into oil cause of the tax benefits, not cause of the merit of the enterprise... actually you'd lose money if they found oil cause it'd create a paper gain which you'd pay taxes on. So the capital raising issue was now done away with for Oil drilling at the expense of driving capital away from technology, medicine, alternative fuels that would've meant that the BP spill might've never happened cause the oil rig would've never been there since we would have divested from oil long ago.
Banking - Banks can be a risky proposition with tight margins. The problems being if the bank takes too much risk then depositors begin to take money out to move it to a safer bank, which would cause a bank run since banks don't have enough money to cover all their deposits in the FRACTIONAL RESERVE banking system we have now. On the other hand, if they practice safer banking practices and keep their depositors then their margins are very low and the growth of the company is low which is not what investors want to hear. So if we could prevent investors from worrying about risk that the banks taking, then the bank take on the risk necessary to get all the investment they need, so FDIC/SIPC are born. By creating a mandatory deposit insurance depositors feel at ease and become less concerned with moving their deposits, allowing banks with those deposits to get bigger and bigger by taking on more risk, while making hard and near impossible for newer banks to compete for those deposits without taking more risk as well.
Housing - Houses are a great investment but a house can take a long time to turn over, especially these days. If you factor in all the maintenance costs it can require a lot of upfront capital and not much in return in the mean time. Countless institutions were created to encourage investment in housing:
- Fannie and Freddie were created to buy mortgages from banks, so banks could keep making more and more mortgages which solves the demand/turnover issue that made investment in development weary.
- Housing which by all means is a capital good doesn't get taxes as a capital gain when sold for a profit, maximizing it's after-tax return versus stocks or bonds which are more liquid.
- REITS which are just real estate company shares get special Subchapter M tax treatment getting the same tax exemptions that mutual funds get.
- Mortgage Tax Credit
- Tax Shelters like the ones created for oil were created for housing, which actually allowed you invest non-recourse loans (loans in which they CAN'T garnish your wages or repossess your assets if you don't pay)
... a lot lot more...
Risk # 2 - Liabilities
Liability is a huge issue to any investor or entrepreneur, the more likely the chances of being sued or a disaster occurring that would incur lots of liabilities the less appetizing the reward becomes versus the risk. So if the liabilities aren't mitigated through government intervention, needless to say a lot of these risks would drive entrepreneurs and investors to more safe sustainable ventures where they can make a similar return. Even if the if they do decide to go into the enterprise, liability will keep the entrepreneur disciplined or else lose his hard work and more.
Oil - Everyone has heard about the liability cap set on Oil companies, on top of it you had tax incentives to drill farther off shore then drilling on shore (less royalties needed to be paid the father out you drilled) which combined makes the risk/reward calculation on drilling offshore a no brainer.
Banking - Once again you had very huge liability in the case that a risky investment didn't pan out, or if depositors suddenly began withdrawing money despite the the cover of FDIC. To prevent the liability of these scenarios the Federal Reserve was created as the lender of last resort, originally created in 1913 to address problems from severe branching regulations in the early 1900's. So with FDIC and keeping depositors feeling safe and the Federal Reserve coming to the rescue when excessive risk catches up with the banks... owning a bank is great idea, especially since it's the bankers who are the entry point of new highly powered money.
Housing - The major liability in investing in housing is well... not being able to sell the house or the person you lend to not making their mortgage payments. Fannie and Freddie combined with loose monetary policy from the fed really fed the demand so that these houses were more liquid and that mortgages could be affordable to the least qualified of borrowers. If you don't have to worry about these factors well... then why not invest in housing.
Risk #3 - Attracting Talent
In order to grow a large and ever growing enterprise one must attract the talent to do so. The problem if your business isn't very sustainable cause of excessive liabilities or low margins then compensation becomes difficult to afford for good talent. Also, the best talent seeks to be somewhere that the job seems safe and secure so if you decide to run a high risk business this may detract talent cause the risk of unemployment becomes to penalizing and the cost of private unemployment insurance would lower your wages you'd make more paying a much smaller premium for a safer company. In this Free Market environment the best talent would gravitate towards sustainable enterprise unless government reduces the risk of working for risky unsustainable enterprise.
For All Industries - Government Mandated Unemployment insurances creates non-variable cost for working for anyone, so it doesn't matter how safe the job is the payment into unemployment is the same, so then you might as well work for the high risk taking high salary company. Worse comes to worse you will not get a fraction of a larger salary for the next 6 months, so you get rewards for taking the riskier job since you benefits key into what you made before becoming unemployed.
Conclusion
If the government makes it easier for capital to gravitate towards riskier business, makes it easier to take more risk without incurring large liabilities, and allows these firms to easily make grabs at all the greatest talent around the globe... what do you expect to happen? Overpriced Housing, Overleveraged Banks, Oil Spills
Greed is not alone powerful enough to cause these kinds of problems, but with the helping hand of government big business can have all the roadblocks removed from becoming... "too big to fail" or better put "too big to succeed"
by Alex Merced
Time and time again we hear in the news that we need stronger regulation on Oil, Housing, and Banking to prevent all the problems we've seen over the last few years. Today, I'd like to make the argument that the problems with all three of these sectors has everything to do with government intervention in the market and that the best regulation would be the natural regulation of natural risk in the markets. In the name of populism much of this natural risk has been removed from these enterprises in the name of "promoting business", "job creation", and "economic growth".
The initial problem with this rhetoric is that growth is always good, so rushing growth or artificial growth must be good too. For example, if I want to bulk up quicker I could begin to take steroids, although while that is growth it's not sustainable since I haven't built the discipline and lifestyle needed to maintain that bulk, so I become dependent on the steroids to maintain it.
So let's take a look at three types of natural risk that effect the entrepreneur when they are making the decision to enter an enterprise, and on how to run the enterprise. We'll see that these policies remove the aforementioned risks and like steroids prevent the kind of discipline needed to create sustainable businesses and growth.
Risk # 1 - The Ability to Raise Capital
Arguably, if an entrepreneur can't raise the money then he may never start the enterprise at all. Why would raising capital be difficult? This could be for a variety of reasons that all have to deal with he viability of the business and if potential investors/lenders see a demand for product/service, are the potential liabilities addressed, are the margins too thin, is it profitable in the short term? If government were to intervene to make capital easier to raise for such enterprises, it's easy to see how more of them would exist despite these typical investor concerns.
Oil - Oil is a very difficult business without government aid, because investors aren't typically very optimistic about the chances of finding oil when doing exploratory drilling. So to encourage investment into oil in the 60's and 70's tax shelters were created for oil investment in the form of Direct Participation Programs, and during a time of 70% tax rates one can see how a tax haven can be quite a benefit, you'd actually profit from the tax savings alone. So capital was being sucked into oil cause of the tax benefits, not cause of the merit of the enterprise... actually you'd lose money if they found oil cause it'd create a paper gain which you'd pay taxes on. So the capital raising issue was now done away with for Oil drilling at the expense of driving capital away from technology, medicine, alternative fuels that would've meant that the BP spill might've never happened cause the oil rig would've never been there since we would have divested from oil long ago.
Banking - Banks can be a risky proposition with tight margins. The problems being if the bank takes too much risk then depositors begin to take money out to move it to a safer bank, which would cause a bank run since banks don't have enough money to cover all their deposits in the FRACTIONAL RESERVE banking system we have now. On the other hand, if they practice safer banking practices and keep their depositors then their margins are very low and the growth of the company is low which is not what investors want to hear. So if we could prevent investors from worrying about risk that the banks taking, then the bank take on the risk necessary to get all the investment they need, so FDIC/SIPC are born. By creating a mandatory deposit insurance depositors feel at ease and become less concerned with moving their deposits, allowing banks with those deposits to get bigger and bigger by taking on more risk, while making hard and near impossible for newer banks to compete for those deposits without taking more risk as well.
Housing - Houses are a great investment but a house can take a long time to turn over, especially these days. If you factor in all the maintenance costs it can require a lot of upfront capital and not much in return in the mean time. Countless institutions were created to encourage investment in housing:
- Fannie and Freddie were created to buy mortgages from banks, so banks could keep making more and more mortgages which solves the demand/turnover issue that made investment in development weary.
- Housing which by all means is a capital good doesn't get taxes as a capital gain when sold for a profit, maximizing it's after-tax return versus stocks or bonds which are more liquid.
- REITS which are just real estate company shares get special Subchapter M tax treatment getting the same tax exemptions that mutual funds get.
- Mortgage Tax Credit
- Tax Shelters like the ones created for oil were created for housing, which actually allowed you invest non-recourse loans (loans in which they CAN'T garnish your wages or repossess your assets if you don't pay)
... a lot lot more...
Risk # 2 - Liabilities
Liability is a huge issue to any investor or entrepreneur, the more likely the chances of being sued or a disaster occurring that would incur lots of liabilities the less appetizing the reward becomes versus the risk. So if the liabilities aren't mitigated through government intervention, needless to say a lot of these risks would drive entrepreneurs and investors to more safe sustainable ventures where they can make a similar return. Even if the if they do decide to go into the enterprise, liability will keep the entrepreneur disciplined or else lose his hard work and more.
Oil - Everyone has heard about the liability cap set on Oil companies, on top of it you had tax incentives to drill farther off shore then drilling on shore (less royalties needed to be paid the father out you drilled) which combined makes the risk/reward calculation on drilling offshore a no brainer.
Banking - Once again you had very huge liability in the case that a risky investment didn't pan out, or if depositors suddenly began withdrawing money despite the the cover of FDIC. To prevent the liability of these scenarios the Federal Reserve was created as the lender of last resort, originally created in 1913 to address problems from severe branching regulations in the early 1900's. So with FDIC and keeping depositors feeling safe and the Federal Reserve coming to the rescue when excessive risk catches up with the banks... owning a bank is great idea, especially since it's the bankers who are the entry point of new highly powered money.
Housing - The major liability in investing in housing is well... not being able to sell the house or the person you lend to not making their mortgage payments. Fannie and Freddie combined with loose monetary policy from the fed really fed the demand so that these houses were more liquid and that mortgages could be affordable to the least qualified of borrowers. If you don't have to worry about these factors well... then why not invest in housing.
Risk #3 - Attracting Talent
In order to grow a large and ever growing enterprise one must attract the talent to do so. The problem if your business isn't very sustainable cause of excessive liabilities or low margins then compensation becomes difficult to afford for good talent. Also, the best talent seeks to be somewhere that the job seems safe and secure so if you decide to run a high risk business this may detract talent cause the risk of unemployment becomes to penalizing and the cost of private unemployment insurance would lower your wages you'd make more paying a much smaller premium for a safer company. In this Free Market environment the best talent would gravitate towards sustainable enterprise unless government reduces the risk of working for risky unsustainable enterprise.
For All Industries - Government Mandated Unemployment insurances creates non-variable cost for working for anyone, so it doesn't matter how safe the job is the payment into unemployment is the same, so then you might as well work for the high risk taking high salary company. Worse comes to worse you will not get a fraction of a larger salary for the next 6 months, so you get rewards for taking the riskier job since you benefits key into what you made before becoming unemployed.
Conclusion
If the government makes it easier for capital to gravitate towards riskier business, makes it easier to take more risk without incurring large liabilities, and allows these firms to easily make grabs at all the greatest talent around the globe... what do you expect to happen? Overpriced Housing, Overleveraged Banks, Oil Spills
Greed is not alone powerful enough to cause these kinds of problems, but with the helping hand of government big business can have all the roadblocks removed from becoming... "too big to fail" or better put "too big to succeed"
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